Death Notices Headed Off at the Branch

Here's the perception: Banks are shuttering traditional branches in the face of mounting competition and cost pressures.

Here's the reality: The number of commercial bank branches in the United States has been increasing in recent years.

How can this be? One of the most trumpeted trends in the industry has been the move from expensive brick-and-mortar to more eficient and electronic alternatives like automated teller machines and telephone service centers. And that's not to mention the countless branch closings following in-market mergers.

To be sure, there have been some significant branch closings unrelated to acquisitions. Earlier this year, for example, CoreStates Financial Corp. and AmSouth Bancorp. announced planned branch reductions of 10% and 14%, respectively.

But moves like those are the exception. Since 1991, the number of commercial bank branches has increased from 52,080 to 54,655, according to Federal Deposit Insurance Corp. data.

True, the increase reflects the growing popularity of supermarket and other in-store branches. But there are just 2,400 supermarket offces nationally. Even if all of them had been built since 1991, they still wouldn't account for the total increase of 2,575 branches during the period.

It's also true that the FDIC numbers don't say how many of the new branches came with bank acquisitions of savings and loans. But S&L conversions, while a factor in the increase of banks' branches, are far from a major one: the total number of bank and savings bank branches in 1994 (69,632) was barely smaller than the total three years earlier (69,700).

Hardly the stuff of the highly touted revolution in banking delivery systems.

I think we're all waiting to see 'where's the beef' on the big branch implosion that everyone's been talking about, said David Tetenbaum, vice president at First Manhattan Consulting Group.

We haven't seen a management team have the guts yet to close the number of branches that I personally believe that they should, said Donaldson, Lufkin & Jenrette analyst Thomas K. Brown. He would like to see branch networks shrink by a third over the next three years, he said.

Analysts say several factors explain why banks have been slow to pare down their branch networks. These include a favorable interest rate spread on deposits, customer acceptance of alternative delivery channels, poor management information about customer profitability, and a lingering fear that customers who banked at closed offces will take their business to competitors.

Still, analysts agree that while these factors have hindered widespread branch closings, there are larger forces at work that will eventually accelerate the process. James McCormick, president of First Manhattan, said he expects the number of traditional branches to decline at least 25% by the year 2000.

By far and away the majority of banks have targets for reduced numbers of traditional branches, said Mr. McCormick. The simple driving force will be that the branch costs make 60% of households served today unprofitable.

Mr. McCormick said this situation can't persist and banks will need to lower distribution costs significantly. The only way it's halfway economic now is there is a massive subsidy going on, he said. The most profitable customers are paying for way more than they need to.

While such pressure has yet to result in massive branch closings, it has led to other moves. A number of banks, including Firstar Corp. in Milwaukee (see cover story), are deploying more sophisticated information systems to measure customer profitability and track actual transaction behavior. In April, First Chicago Corp. announced a plan to levy fees of up to $3 for some customers who transact business at a teller when it could be done over the phone or at an ATM.

What Firstar and First Chicago are trying to do is make some of these unprofitable relationships profitable by both raising revenues and by reducing the cost to serve, said Mr. Brown. I think both companies ought to not only be applauded but emulated.

First Chicago's bold new fee structure may be seen as designed to discourage unprofitable customers from banking there.

Talk about using the stick, said David S. Berry, director of research at Keefe, Bruyette & Woods Inc. in New York. It's almost like it was designed to grab headlines. Maybe (they) are purposely chasing out the customers (they) weren't making money on.

One reason First Chicago's move stood out was that profits have not been lacking in its consumer business.

A couple of years ago, when rates were real low, the retail branch system was a real albatross, Mr. Berry said. The value of the deposits gathered was quite a bit less than the fixed costs associated with branch networks.

In the last year, as market interest rates went up and deposit rates did not go up nearly as much, the profitability of the retail branch system has soared, the analyst said.

Mr. Tetenbaum of First Manhattan noted that a bank considering branch closings in the early 1990s could afford to lose about 40% to 50% of the customer base before the move looked unattractive.

But with the recent higher spreads, each customer appears more valuable.

Today, the economics become unattractive almost around 25%, said Mr. Tetenbaum. You have to be very protective of this customer base.

First Manhattan recommends that banks considering branch closings normalize their rate spreads to historical levels. Then you can objectively analyze branch performance and objectively analyze the consolidation benefits.

Even in a normalized rate environment, Mr. Tetenbaum said, there is a reluctance to close those branches because of the fear of losing the customer base.

Mr. Tetenbaum said that fear is rooted in a dogma that physical facilities in convenient locations remain necessary to serve consumers.

Having been in a lot of meetings when it comes down to the final decision, he said, management is reticent to close branches.

Of course, any move to substantially reduce the brick-and-mortar must be accompanied by development of other delivery channels.

Analysts disagree on whether those channels are yet up to speed.

Said Mr. Tetenbaum, I think a lot of banks talk a good talk. But when you dig deeper they really are in the very early stages of developing the functionality required to support the likes of what Citibank is doing with its virtual bank strategy.

But Mr. Brown of Donaldson Lufkin said it's primarily an issue of customer knowledge and acceptance. When Mr. Brown said that when he tells investors about the services some banks offer via the telephone, their follow-up questions suggest it was the first they heard of it.

But many in the industry now say that alternative delivery strategies are poised to take off. Last year, 27% of all customer contact with banks was via the ATM, the telephone, or other electronic means, according to a 1994 American Banker/ Tower Group/Andersen Consulting survey.

That figure is expected to rise to 50% by the year 2000. The percentage of customer transactions handled in the branch is expected to decline from 66% to 42% during the period.

People have talked about phone banking or computer banking for over 10 years, and there have been a lot of pilot efforts to get PC banking to work and they've all failed, said Mr. Berry of Keefe Bruyette. It just seems in the last year or two that this kind of stuff is finally beginning to take off.

While no one is saying that branches will completely fade as a vehicle for distribution, there is a consensus that offces will be reconfigured to focus less on transactions and more on sales.

But that, too, presupposes that many more transactions will be handled outside the branch. Analysts say another reason why banks have generally been slow to close branches is a lack of reliable information about customer profitability.

As a generalization, it's horrible and needs to be improved dramatically, said Mr. McCormick of First Manhattan. There are about five banks in the top 50 that have really good customer profitability information.

Mr. McCormick's list includes some of First Manhattan's clients: First Chicago, BankAmerica Corp., and Chemical Banking Corp.

He added that Banc One Corp. and Crestar Financial Corp. have recently joined the small group.

According to Mr. McCormick, an effective profitability system must include actual customer transaction behavior.

Banks make decisions now on mythology and averages, he said. They look at average product profitability.

Focusing on the average is not useful, he said, because the large number of unprofitable customers brings down the figure.

In short, he said, it assumes that transaction costs for all customers are the same. That's dramatically incorrect, he said.

Further, decisions about branch closings and alternative delivery channels must be viewed in the context of what a bank can afford, he said.

Assuming that my most profitable customers will pay a reasonable share of the costs (and not subsidize unprofitable customers), what sort of distribution can I afford if I have the strategic goal of making 90% of my customers profitable? You can calculate a number, he said.

Mr. Tetenbaum said that good information about product and channel usage and transaction behavior requires banks to develop customized customer segmentation.

You can't rely on these off-the-shelf, generic segmentation programs to come up with true tactical action programs to improve your profitability, he said.

Finally, First Manhattan's Mr. McCormick said that alternative delivery channels can be more effectively used to serve diVerent levels of customers, creating a kind of high-tech version of high-touch.

You can have some phone numbers where a computer answers. You can have some phone numbers where a very skilled high-touch service representative answers, he said. It turns out that nonbranch distribution may be a better vehicle for offering diVerent levels of service than the branch.

Using those newer approaches, he said, can also help banks retain customers when they shutter branches.

I don't know anyone out there who said, 'Gee, I closed 10% of my branches. Boy, am I sorry I did that.' Nobody.